Comments on UK version of Chapter 11

Date Published: 22nd August 2008

John Kelly, the Regional Managing Partner of Begbies Traynor in the Midlands and South West, and national head of the Banking Group, welcomes a review as he believes the current procedures are not working and are being undermined by government departments. At issue is whether the UK should move closer to America’s Chapter 11 system.

The UK’s nearest equivalent is Company Voluntary Arrangements, but there has been a poor take-up of the procedure since it was introduced in 1985. Mr Kelly said: “A CVA is where a company with financial difficulties agrees to repay creditors a percentage of their outstanding debt over a period of time from future profits or new funding.

“The main reasons for the poor uptake appear to be the attitude of HMRC and creditors seeking ‘ransom payments’.

“HMRC looks to a five-year proposal, which in a competitive marketplace is unrealistic, and many creditors seek full repayment of past debt before agreeing to future supplies, so defeating the object of business rescue. Change is needed.”

Mr Cameron recently announced that his party would consult on taking the best aspects of Chapter 11 and give solid businesses breathing space to allow them to rescue or restructure in the teeth of the credit crunch. He claimed: “This change will ensure that fewer good companies end up in liquidation and fewer people lose their jobs through no fault of their own.” But he offered no detail on what aspects the Tories might want to run with. That prompted an immediate response from the CBI’s deputy director-general, John Cridland.

He said: “Business would be interested in any proposals that give companies breathing space when faced with unexpected liquidity problems. However, the ramifications need to be carefully considered as does the potential for benefits over and above the existing Enterprise Act.

“Many companies are likely to be involved when one business faces difficulties, and the challenge with any insolvency regime is to balance up all these interests.”

The comments were echoed by Mr Kelly who added: “There is also an ever increasing need to develop funding to assist businesses faced with financial challenges. “However, Chapter 11 is controversial and opinions differ over the extent to which it balances creditor rights and the opportunity to return a company to being a profitable entity.

“We need to be cautious about what we take from America and I will be very interested to see what proposals the Conservatives come up with.” A host of major US companies, many in the airline industry, have filed for Chapter 11 in recent years.

The intention of the legislation, which comes under the Bankruptcy Code, is to allow for a reorganisation of the company, hopefully resulting in the rehabilitation of a faltering business.

Sometimes it successfully works out a plan to return to profitability; sometimes, in the end, it liquidates.

Under Chapter 11, a company usually keeps doing business and continues to trade.

Critics claim the system is excessively lenient in giving a needless "escape hatch" to the incompetent management of a failing firm, allowing them to continue in charge and damaging the efficiency of the wider economy – in the States it is unusual for the executives to be sacked in such an eventuality, as it is usually assumed they know far more about the company and its customers than would a new team.

Another concern is that a company is effectively operating under the "protection" of the court until it emerges, in some cases giving the bankrupt concerned a great advantage over its rivals, distorting the market and harming more competitive businesses.

Where a key market participant, or indeed more than one, goes into Chapter 11, it can also result in significant over-capacity in the industry. In 2006 over half the US aviation industry's seating capacity was on airlines that were in Chapter 11. These airlines were able to stop making debt payments, freeing up cash to expand routes or weather a price war – all with the bankruptcy court's approval.

Others condemn the process on the basis that, by forestalling the creditors' rights to enforce their security in the event of non-payment, it reduces the economic value of collateral in the United States, and thereby increases the cost of secured lending.

About the author

Mark Malone


Meet our Team of Experts

Mark is a Partner based in our Birmingham office, but covers the whole Midlands region. He is a Chartered Certified Accountant and also a Licensed Insolvency Practitioner. He joined Begbies Traynor in 2005 having previously gained his ACCA qualification and now has many years restructuring and insolvency experience. He regularly advises directors, management teams and lenders of insolvency options across a range of different sectors and also frequently prepares independent business reviews.

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